<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended March 28, 1999
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _______ to _______
Commission file number 0-19360
VERILINK CORPORATION
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
DELAWARE 94-2857548
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
145 BAYTECH DRIVE, SAN JOSE, CALIFORNIA 95134
- --------------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
408-945-1199
- --------------------------------------------------------------------------------
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No [ ]
The number of shares outstanding of the issuer's common stock as of April 26,
1999 was 13,880,431.
<PAGE> 2
INDEX
VERILINK CORPORATION
FORM 10-Q
<TABLE>
<CAPTION>
PART I. FINANCIAL INFORMATION PAGE NO.
- ------- --------------------- --------
<S> <C> <C>
Item 1. Financial Statements
Condensed Consolidated Statements of Operations for the 3
three months and nine months ended March 28, 1999
and March 29, 1998
Condensed Consolidated Balance Sheets as of 4
March 28, 1999 and June 28, 1998
Condensed Consolidated Statements of Cash Flows for 5
the nine months ended March 28, 1999 and March 29, 1998
Notes to Condensed Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of 9
Financial Condition and Results of Operations
Item 3. Quantitative and Qualitative Disclosures About Market Risk 19
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K 20
SIGNATURES 21
</TABLE>
2
<PAGE> 3
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
VERILINK CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
---------------------- ----------------------
March 28, March 29, March 28, March 29,
1999 1998 1999 1998
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Net sales $ 12,003 $ 14,081 $ 46,187 $ 33,612
Cost of sales 7,392 7,361 24,153 17,249
-------- -------- -------- --------
Gross profit 4,611 6,720 22,034 16,363
Operating expenses:
Research and development 3,964 3,639 10,654 9,201
Selling, general and administrative 6,372 4,034 16,860 11,590
In-process research and development -- -- 3,330 --
Restructuring charge 3,200 -- 3,200 --
-------- -------- -------- --------
Total operating expenses 13,536 7,673 34,044 20,791
Loss from operations (8,925) (953) (12,010) (4,428)
Interest and other income, net 275 483 1,242 1,565
-------- -------- -------- --------
Loss before provision for income taxes (8,650) (470) (10,768) (2,863)
Provision for (benefit from) income taxes -- -- 389 (889)
-------- -------- -------- --------
Net loss $ (8,650) $ (470) (11,157) $ (1,974)
======== ======== ======== ========
Net loss per share - Basic and diluted $ (0.62) $ (0.03) (0.80) (0.14)
======== ======== ======== ========
Shares used in per share computations -
Basic and diluted 14,020 13,798 13,952 13,706
======== ======== ======== ========
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
3
<PAGE> 4
VERILINK CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands)
<TABLE>
<CAPTION>
March 28, June 28,
--------- --------
1999 1998
------- -------
(unaudited)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $20,988 $16,304
Short-term investments 6,317 26,111
Accounts receivable, net 6,002 5,992
Inventories 6,842 4,900
Deferred tax assets 1,532 1,532
Other current assets 293 342
------- -------
Total current assets 41,974 55,181
Property and equipment, net 8,248 7,047
Deferred tax assets 436 436
Intangible assets, net 5,877 --
Other assets 3,013 1,164
------- -------
Total assets $59,548 $63,828
======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 2,695 $ 2,527
Accrued expenses 12,976 6,747
Income taxes payable 624 744
------- -------
Total liabilities 16,295 10,018
Stockholders' equity 43,253 53,810
------- -------
Total liabilities and stockholders' equity $59,548 $63,828
======= =======
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
4
<PAGE> 5
VERILINK CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands, unaudited)
<TABLE>
<CAPTION>
Nine Months Ended
March 28, March 29,
-------- --------
1999 1998
-------- --------
<S> <C> <C>
Cash flows from operating activities:
Net loss $(11,157) $ (1,974)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization 2,270 1,705
In-process research and development 3,330 --
Deferred compensation related to stock options 122 121
Deferred income taxes -- (883)
Accrued interest on notes receivable from (11) (166)
Non-cash restructuring related costs 264 --
Changes in assets and liabilities:
Accounts receivable 2,622 288
Inventories (232) (1,259)
Other assets (1,780) (619)
Accounts payable (785) 326
Accrued expenses 2,162 766
Income tax payable (120) 363
-------- --------
Net cash used in operating activities (3,315) (1,332)
-------- --------
Cash flows from investing activities:
Purchases of property and equipment (2,274) (1,580)
Purchases of short-term investments -- (22,753)
Maturities of short-term investments 19,794 9,884
Purchase of TxPort, Inc. (10,000) --
-------- --------
Net cash provided by (used in) investing activities 7,520 (14,449)
-------- --------
Cash flows from financing activities:
Proceeds from issuance of common stock, net 801 848
Purchases of treasury stock (322) --
-------- --------
Net cash provided by financing activities 479 848
-------- --------
Net increase (decrease) in cash and cash equivalents 4,684 (14,933)
Cash and cash equivalents at beginning of period 16,304 36,596
-------- --------
Cash and cash equivalents at end of period $ 20,988 $ 21,663
======== ========
Supplemental disclosures:
Cash paid for (refund from) income taxes $ 495 $ (363)
======== ========
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
5
<PAGE> 6
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
NOTE 1. Interim Financial Statements
The accompanying unaudited interim condensed consolidated financial
statements of Verilink Corporation (the "Company") have been prepared in
accordance with generally accepted accounting principles for interim financial
information and with the instructions to Form 10-Q and Article 10 of Regulation
S-X. Accordingly, they do not include all of the information and footnotes
required by generally accepted accounting principles for complete financial
statements. In the opinion of management, these statements include all
adjustments, consisting of normal and recurring adjustments, considered
necessary for a fair presentation of the results for the periods presented. The
results of operations for the periods presented are not necessarily indicative
of results which may be achieved for the entire fiscal year ending June 27,
1999. The unaudited interim condensed consolidated financial statements should
be read in conjunction with the financial statements and notes thereto contained
in the Company's Annual Report on Form 10-K for the fiscal year ended June 28,
1998 as filed with the Securities and Exchange Commission.
NOTE 2. Inventories
Inventories are stated at the lower of cost, determined using the first-in,
first-out method, or market. Inventories consisted of the following (in
thousands):
<TABLE>
<CAPTION>
March 28, June 28,
-------- -------
1999 1998
------ ------
<S> <C> <C>
Raw materials $2,663 $2,313
Work in process 1,077 926
Finished goods 3,102 1,661
------ ------
$6,842 $4,900
====== ======
</TABLE>
NOTE 3. Earnings Per Share
Basic earnings per share (EPS) is computed by dividing net income available
to common stockholders (numerator) by the weighted average number of common
shares outstanding (denominator) during the period. Diluted EPS gives effect to
all dilutive potential common shares outstanding during a period. In computing
diluted EPS, the average price for the period is used in determining the number
of shares assumed to be purchased from exercise of stock options. Earnings per
share for all periods presented have been restated to conform to the SFAS 128
requirements.
Options to purchase 2,675,242 shares of common stock at prices ranging from
$0.50 to $10.38 per share were outstanding at March 28, 1999 but were not
included in the computation of diluted EPS because inclusion of such options
would have been antidilutive.
6
<PAGE> 7
NOTE 4. Recent Accounting Pronouncements
In June, 1997, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards No. 130 ("SFAS 130"), "Reporting
Comprehensive Income". SFAS 130 establishes standards for reporting
comprehensive income and its components in a financial statement that is
displayed with the same prominence as other financial statements. Comprehensive
income, as defined, includes all changes in equity (net assets) during a period
from non-owner sources. Examples of items to be included in comprehensive
income, which are excluded from net income, include foreign currency translation
adjustments and unrealized gain/loss on available-for-sale securities. No
comprehensive income information has been presented as the impact of the
disclosure required by SFAS 130 is immaterial to the financial statements of the
Company.
In June, 1997, the FASB issued Statement of Financial Accounting Standards
No. 131 ("SFAS 131"), "Disclosures about Segments of an Enterprise and Related
Information". This statement establishes standards for the way companies report
information about operating segments in annual financial statements. It also
establishes standards for related disclosures about products and services,
geographic areas, and major customers. The disclosures prescribed by SFAS 131
are effective for the fiscal year ending June 27, 1999 but are not required for
interim financial statements in 1999. The Company does not anticipate to have
segments during the current fiscal year.
NOTE 5. Related Party Transactions
In September 1998, the Company began occupying an additional 16,000 square
feet of space at 161 Nortech Drive leased from Baytech Associates ("Baytech") in
accordance with an agreement currently under negotiation. Baytech is owned by
two stockholders who are Directors of the Company. The Company has agreed to
loan Baytech funds for leasehold improvements and rent obligations at 161
Nortech Drive in consideration of certain lease concessions made by Baytech to
the Company. As of April 26, 1999, $349,000 was borrowed by Baytech against this
facility. The loan to Baytech is evidenced by a promissory note bearing interest
at 8% and will be payable out of the net lease proceeds received by Baytech from
leasing a portion of the Nortech building.
In September 1998, the Company provided a Director with a loan facility not
to exceed $1,000,000 at an interest rate of 6% per annum. As of April 26, 1999,
$986,000 was borrowed against that facility. All loans made pursuant to this
facility are due on or before December 31, 1999.
In October 1998, the Company guaranteed $500,000 in borrowings made by one
of its Directors by pledging as collateral $500,000 on deposit with the lending
institution (CivicBank of Commerce) and agreed to provide that Director with a
loan facility not to exceed $3,000,000, including the guaranty. As of April 26,
1999, $1,005,000 was borrowed against that facility. All loans made pursuant to
this loan facility will be due on or before December 31, 1999. This loan
facility is currently secured by a pledge of the Director's general partnership
interest in Baytech Associates.
7
<PAGE> 8
NOTE 6. Acquisitions
Effective November 16, 1998, the Company completed its acquisition of
TxPort, Inc. ("TxPort") from Acme-Cleveland Corporation, by purchasing all the
outstanding shares of TxPort at a cost of $10,500,000. TxPort is a manufacturer
of high speed voice and data communications products.
The transaction was accounted for using the purchase method, and the
purchase price was allocated to the assets acquired and liabilities assumed
based on the estimated fair market values at the date of acquisition. The
in-process research and development, which was expensed at the acquisition
date, represented the estimated current fair market value of specified
technologies which had not reached technological feasibility and had no future
uses at the date of acquisition.
The results of the operations acquired were included with those of the
Company from the date of acquisition. Intangible assets have been recorded as
other assets, and are amortized over estimated useful lives between three and
ten years. The allocation of the purchase price was as follows (in thousands):
<TABLE>
<CAPTION>
<S> <C>
In-process research and development $ 3,330
Intangible assets 6,233
Receivables 2,632
Inventory 1,710
Other assets 10
Property and equipment 841
Liabilities assumed (4,256)
-------
Total $10,500
=======
The total purchase price is as follows:
Cash payment $10,000
Other expenses 500
-------
Total $10,500
=======
</TABLE>
The following unaudited pro forma financial information is presented to give
effect to the purchase as if the transaction had occurred as of the beginning
of each of the periods presented. The pro forma information gives effect of
certain adjustments, including amortization of goodwill and other intangibles,
based on the value allocated to assets acquired in the purchase. In-process
research and development costs of $3,300,000, which were written off
immediately after the purchase was completed, and all non-recurring and related
party transactions are excluded from the results of both periods presented.
The pro forma information is presented for illustrative purposes only and does
not purport to be indicative of the operating results that would have occurred
had the acquisition been effected for the periods indicated nor is it indicative
of the future operating results of the Company.
<TABLE>
<CAPTION>
(in thousands, except per share amounts)
----------------------------------------
Nine months ended
----------------------------------------
March 28, 1999 March 29, 1998
-------------- --------------
<S> <C> <C>
Pro forma net sales $ 54,047 $ 51,944
Pro forma net loss $ (5,686) $ (2,731)
Pro forma loss per share - Basic and diluted $ (0.41) $ (0.20)
Shares used in per share computation - 13,952 13,706
Basic and diluted
</TABLE>
8
<PAGE> 9
[S]
NOTE 7. Restructuring Charge
During the current quarter, the Company announced and began implementing
its plans to streamline operations and eliminate redundant functions by
consolidating manufacturing, combining sales and marketing functions, and
restructuring research and development activities. This will result in a
reduction in workforce of approximately 52 employees, or 13% of the Company's
total workforce. As of March 28, 1999, approximately 37 employees were separated
from the Company.
As a result, the Company incurred a pretax restructuring charge of
$3,200,000 during March, 1999. The components of the restructuring reserve and
charges to the reserve during the current quarter are as follows:
Restructuring
Reserve
(Unaudited)
<TABLE>
<CAPTION>
Reduction in
Workforce Other Costs Total
---------------------------------------------
<S> <C> <C> <C>
Beginning reserve balance $ 2,916,000 $ 284,000 $ 3,200,000
Current quarter charges (304,132) (264,000) (568,132)
---------------------------------------------
Ending reserve balance $ 2,611,868 $20,000 2,631,868
---------------------------------------------
</TABLE>
The reserve for reduction in workforce includes severance, related medical
benefits and other termination benefits or obligations to employees. The
workforce reductions were in the sales, marketing, engineering and operations
functions and impacted employees in California and Alabama.
The reserve for other restructuring costs primarily relates to the
write-off of employee loans who were part of the reduction in workforce plan.
The Company expects the restructuring activities to be substantially complete by
the end of the current fiscal year.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
This Report on Form 10-Q contains forward-looking statements within the
meaning of Section 27A of the Securities Act of 1933 and Section 21E of the
Securities Exchange Act of 1934, including statements regarding the Company's
beliefs, expectations, intentions, hopes, plans and goals regarding the future
and statements regarding the Company's research and development expenditures,
selling, general and administrative expenditures, restructuring activities and
charges, reductions in operating, spending, anticipated capital expenditures,
future capital requirements, adequacy of facilities, and Year 2000 planning,
assessment and remediation efforts. Actual results could differ from those
projected in any forward-looking statements for the reasons detailed below and
in the Sections entitled "Factors Affecting Future Results" and other sections
of this Report on Form 10-Q. The forward-looking statements included on this
Form 10-Q are based on information available to the Company as of the date of
this Report on Form 10-Q, and the Company assumes no obligation to update the
forward-looking statements, or to update the reasons why actual results could
differ from those projected in the forward-looking statements. Investors should
also consult the risk factors listed from time to time in the Company's Reports
on Form 10-K and Annual Report to Stockholders.
RESULTS OF OPERATIONS
During the second quarter of fiscal 1999, the Company acquired TxPort, a
manufacturer of high speed voice and data communications products, based in
Huntsville, Alabama for $10,000,000 in cash, paid out of the Company's working
capital. Accordingly, the results of operations of TxPort, commencing from
November 16, 1998, the date of acquisition, are consolidated in the Company's
operating results for fiscal 1999.
The following table presents the percentages of total sales represented by
certain line items from the Condensed Consolidated Statements of Operations for
the periods indicated.
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
---------------------- ----------------------
March 28, March 29, March 28, March 29,
--------- --------- --------- ---------
1999 1998 1999 1998
----- ----- ----- -----
<S> <C> <C> <C> <C>
Sales 100.0% 100.0% 100.0% 100.0%
Cost of sales 61.6 52.3 52.3 51.3
----- ----- ----- -----
Gross margin 38.4 47.7 47.7 48.7
----- ----- ----- -----
Operating expenses:
Research and development 33.0 25.8 23.1 27.4
Selling, general and administrative 53.1 28.6 36.5 34.5
In-process research and development -- -- 7.2
Restructuring charge 26.7 -- 6.9 --
----- ----- ----- -----
Total operating expenses 112.8 54.4 73.7 61.9
----- ----- ----- -----
Loss from operations (74.4) (6.8) (26.0) (13.2)
Interest and other income, net 2.3 3.4 2.7 4.7
----- ----- ----- -----
Loss before provision for income taxes (72.1) (3.3) (23.3) (8.5)
Provision for (benefit from) income taxes -- -- 0.8 (2.6)
----- ----- ----- -----
Net loss (72.1)% (3.3)% (24.2)% (5.9)%
----- ----- ----- -----
</TABLE>
9
<PAGE> 10
Sales. Net sales for the three months ended March 28, 1999 decreased
approximately 15% to $12 million from $14 million in the comparable period of
the prior fiscal year. This decrease is a result of the decline in demand by the
Company's wireless customers, as well as to a lesser extent, its carrier
customers. Sales to the Company's other major customers also decreased, which
appears to be a result of a major customer focusing its efforts on their network
integration and Year 2000 compliance issues. Sales to the Company's five largest
customers during the three months ended March 28, 1999 accounted for 30% of net
sales as compared to 66% of net sales in the comparable period of the prior
fiscal year.
Net sales for the nine months ended March 28, 1999 increased 37% to $46.2
million from $33.6 million in the comparable period of the prior fiscal year.
Approximately $7.6 million of the current year's sales is attributed to the
former TxPort product lines. Sales to the Company's four largest customers for
the nine months ended March 28, 1999 accounted for 51% of net sales as compared
to 53% of net sales in the comparable period of the prior fiscal year.
Gross Margin. Gross margin decreased to 38.4% of net sales for the three months
ended March 28, 1999 as compared to 47.7% for the three months ended March 29,
1998. The decrease in gross margin is primarily due to factory under utilization
and changes in channel and product mix. Gross margin remained relatively
constant at approximately 47.7% and 48.7% for the nine months ended March 28,
1999 and March 29, 1998, respectively.
Research and Development. Research and development expenditures for the three
months ended March 28, 1999 increased 9% to $4 million from $3.6 million in the
comparable period of the prior fiscal year and increased as a percentage of
sales to 33% from 25.8%. Research and development expenditures for the nine
months ended March 28, 1999 increased 16% to $10.6 million from $9.2 million in
the comparable period in the prior fiscal year and as a percentage of net sales,
decreased to approximately 23% from 27%. The increase in both periods in
absolute dollars is due to an increase in headcount and personnel-related costs
as a result of the TxPort acquisition. Since the Company's reduction in
workforce occurred late in the quarter, it did not impact current quarter
spending. The increase as a percentage of net sales for the three month period
comparison is a result of an increase in personnel related expenses spread over
a lower sales volume. The decrease as a percentage of sales for the nine month
period is a result of a small increase in absolute dollars of research and
development expenses spread over a larger revenue base. The Company believes
that a significant level of investment in product development is required to
remain competitive and that such expenses will vary over time as a percentage of
sales.
Selling, general and administrative. Selling, general and administrative
expenses for the three months ended March 28, 1999 increased 58% to $6.4 million
from $4.0 million in the comparable period of the prior fiscal year and
increased as a percentage of sales to 53.1% from 28.6%. Selling, general and
administrative expenses for the nine months ended March 28, 1999 increased 45.5%
to $16.9 million from $11.6 million in the comparable period of the prior fiscal
year. The increase in spending over the corresponding periods in the prior year
is primarily due to an increase in expenses as a result of the TxPort
acquisition and an increase in costs to support the enterprise resource planning
implementation. The Company expects selling, general and administrative expenses
to increase in the future as a result of increased administrative expenses for
information technology as well as expenses associated with the acquisition.
The Company expects such expenses will vary over time as a percentage of sales.
Restructuring charge. The Company announced and began implementing during the
current quarter, its plans to streamline operations and eliminate redundant
functions by consolidating manufacturing, combining sales and marketing
functions, and restructuring research and development activities. Included as a
part of the restructuring activities was the retirement of the Company's two
founders. The Company incurred a pretax restructuring charge of $3,200,000. See
Note 7 in the Notes to Condensed Consolidated Financial Statements for further
details of the restructuring charge and the restructuring reserve activity
during the current quarter. Approximately $2,930,000 of the restructuring charge
is cash in nature and will be paid out of the Company's working capital.
The Company's restructuring plans will result in a reduction in workforce of
approximately 52 employees, or 13% of the Company's total workforce. As of March
28, 1999, approximately 37 employees were separated from the Company. As a
result of this reduction in workforce, the Company expects to reduce operating
spending by approximately $1 million for each of the next two quarters. The
Company expects the restructuring activities to be substantially completed by
the end of the current fiscal year.
10
<PAGE> 11
In-process research and development. During the nine months ended March 28,
1999, the Company acquired TxPort. As a result of this acquisition, the Company
incurred a one time charge of $3.3 million related to in-process research and
development for which technological feasibility was not achieved at the time of
acquisition.
Interest and Other Income. Net interest and other income was approximately $1.2
million for the nine month period ended March 28, 1999 as compared to $1.6
million in the comparable period of the prior fiscal year. The decrease was a
result of a lower cash and cash equivalents balance as a result of the
TxPort acquisition for which the Company paid $10 million in cash.
Provision for Income Taxes. Based on the estimated taxable income for fiscal
1999, the Company elected not to record a tax benefit or provision for income
taxes for the quarter ended March 28, 1999. For the nine month period ended
March 29, 1998, the Company recorded a 31% benefit from income taxes reflecting
available net operating loss carry-back capacity and expected tax credits.
LIQUIDITY AND CAPITAL RESOURCES
On March 28, 1999, the Company's principal sources of liquidity included
$27.3 million of cash and cash equivalents, and short-term investments.
During the nine month period ended March 28, 1999, the Company used
approximately $3.3 million for operating activities, compared to the $1.3
million used during the nine month period ended March 29, 1998. Net cash used in
operating activities was primarily due to the loss of $11.2 million incurred
through the nine months ended March 28, 1999, partially offset by the non-cash
depreciation and amortization and in-process research and development charge
totaling $5.6 million, a reduction in accounts receivable of $2.6 million and
an increase in accrued expenses of $2.2 million.
Cash provided by investing activities was approximately $7.5 million for
the nine month period ended March 28, 1999, as compared to approximately $14
million used in investing activities for the nine month period ended March 29,
1998. The increase in funds provided by investing activities is primarily a
result of the maturity of short-term investments being reinvested in cash and
cash equivalents of $19.8 million, offset by the purchase of TxPort for $10.0
million. The Company also invested approximately $2.3 million in property and
equipment during the first nine months of fiscal 1999, which is an increase of
approximately $700,000 from the comparable period in the prior year. The Company
anticipates significant capital expenditures for the fourth quarter of fiscal
1999 which are anticipated to be used for ERP software applications and
implementation. In mid-September, the Company began occupying an additional
16,000 square feet of office space. The Company expects its current facilities
to be adequate for its needs through fiscal 2000.
Cash provided by financing activities was approximately $479,000 for the
nine month period ended March 28, 1999, as compared to approximately $848,000
provided for the nine month period ended March 29, 1998. The decrease in funds
provided by financing activities of $369,000 is primarily due to the repurchase
of 89,000 shares at an average price of $3.62 per share.
On February 18, 1999, the Board of Directors authorized the Company's
management to systematically repurchase up to 1,000,000 shares of the Company's
stock. As of April 26, 1999, the Company repurchased a total of 192,500 shares
at an average price of $3.23 per share.
The Company believes that its existing cash and cash equivalents,
short-term investments and anticipated cash flows from operations will satisfy
the Company's near-term cash needs.
11
<PAGE> 12
YEAR 2000
The year 2000 presents concerns which are widespread and complex. If
computer, information or telecommunication systems do not correctly recognize
date information when the year changes to 2000, there could be an adverse impact
on the Company's operations. The Company is evaluating its year 2000 risk as it
exists in four areas: Information technology infrastructure, including reviewing
what actions are necessary to bring all software tools used internally to year
2000 compliance, information systems used by the Company's suppliers, potential
warranty and year 2000 claims from the Company's customers, and the potential
impact of reduced spending by customers or potential customers on
telecommunication network solutions as a result of devoting a substantial
portion of their information system spending to resolve year 2000 compliance
issues.
The Company continues to evaluate its information technology infrastructure
for year 2000 compliance, which includes reviewing what actions are required to
make all software systems used internally year 2000 compliant. For example, the
Company has purchased an enterprise resource planning solution which has been
determined to be year 2000 compliant. The implementation of this ERP solution
requires a material investment by the Company in internal and external
resources. The ERP system began operating on March 29, 1999 and is performing
the daily business operations of the Company. It is the Company's intent for all
software systems and tools that are identified as non-compliant to be either
upgraded or replaced. For the non-compliant systems identified to date, the cost
to bring the systems to year 2000 compliance is not expected to be material to
the Company's operating results. However, if implementation of replacement
systems and tools is delayed, or if significant new non-compliance issues are
identified, the Company's results of operations, business and financial
condition could be materially affected.
The Company is in the process of contacting its key suppliers to determine
that the suppliers operations and the products and services they provide are
year 2000 compliant. The Company anticipates this assessment to be completed by
June, 1999. In the event that any of the Company's key suppliers does not
successfully and timely achieve year 2000 compliance, the Company's business,
financial condition and results of operations could be adversely affected.
All of the Company's products are currently being reviewed for compliance
to year 2000 guidelines. This process includes complete and thorough testing of
current products as well as inclusion of year 2000 requirements in
specifications for future product releases. Based on this review, the
Company believes its current product shipments are year 2000 compliant and that
neither performance nor functionality are affected by dates prior to, during,
and after the year 2000 and that the year 2000 is recognized as a leap year.
However, as all customer events cannot be anticipated, the Company may see an
increase in product warranty and other claims. In the event that any of the
Company's products ultimately are not year 2000 compliant, or there are customer
claims made against the Company, the Company's business, financial condition and
results of operations could be adversely affected.
The Company has not developed a contingency plan to address every potential
year 2000 non-compliance situation that may be present when the year changes to
2000. However, it is the Company's intention to formulate contingency plans in
those areas where year 2000 non-compliance could have a material adverse effect
on the Company's business, financial condition and results of operation. That
plan is currently being developed.
FACTORS AFFECTING FUTURE RESULTS
As described by the following factors, past financial performance should
not be considered to be a reliable indicator of future performance, and
investors should not use historical trends to anticipate results or trends in
future periods.
Customer Concentration. A small number of customers continue to account for
a majority of the Company's sales. For the nine month period ended March 28,
1999, sales to MCI, Nortel, Compuserve and Qualcomm accounted for 20%, 19%, 9%
and 6% of the Company's sales respectively and sales to the Company's top five
customers accounted for 59% of the Company's sales. In fiscal 1998, Nortel, MCI,
Qualcomm and CompuServe accounted for 20%, 16%, 12% and 11% of the Company's
sales, respectively, and sales to the Company's top five customers accounted for
64% of the Company's sales. In fiscal 1997, Nortel, MCI, Qualcomm and CompuServe
accounted for 22%, 20%, 9% and 11%
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<PAGE> 13
of the Company's sales, respectively, and the Company's top five customers
accounted for 67% of the Company's sales. In fiscal 1996, MCI and CompuServe
accounted for 29% and 18% of the Company's sales, respectively, and the
Company's top five customers accounted for 64% of sales. Other than Nortel, MCI,
Qualcomm and CompuServe, no customer accounted for more than 10% of the
Company's sales in fiscal years 1998, 1997, or 1996. There can be no assurance
that the Company's current customers will continue to place orders with the
Company, that orders by existing customers will continue at the levels of
previous periods, or that the Company will be able to obtain orders from new
customers. Certain of the Company's customers have delayed orders in the past as
a result of a diversion of their resources to network integration and the Year
2000 issues. This trend may continue or worsen and result in additional order
delays or cancellations. In addition, certain customers of the Company have been
or may be acquired by other existing customers. The impact of such acquisitions
on sales to such customers is uncertain, but there can be no assurance that such
acquisitions will not result in a reduction in sales to those customers. In
addition, such acquisitions could result in further concentration of the
Company's customers. The Company has in the past experienced significant
declines in sales it believes were in part related to orders being delayed or
cancelled as a result of pending acquisitions relating to its customers. There
can be no assurance future merger and acquisition activity among the customers
will not have a similar adverse affect on the Company's sales and results of
operations. The Company's customers are typically not contractually obligated to
purchase any quantity of products in any particular period. Product sales to
major customers have varied widely from period to period. In some cases, major
customers have abruptly terminated purchases of the Company's products. Loss of,
or a material reduction in orders by, one or more of the Company's major
customers has materially adversely affected the Company's business, financial
condition and results of operations in the past and may do so in the future. See
"Competition" and "Fluctuations in Quarterly Operating Results".
Fluctuations in Quarterly Operating Results. The Company's sales are
subject to quarterly and annual fluctuations due to a number of factors
resulting in more variability and less predictability in the Company's
quarter-to-quarter sales and operating results. For example, sales to MCI,
Nortel, Qualcomm and CompuServe have varied between quarters by as much as $4.0
million and were the major contributor to the variability of quarterly sales in
fiscal years 1998 and 1999. Most of the Company's sales are in the form of large
orders with short delivery times. The Company's ability to affect and judge the
timing of individual customer orders is limited. The Company has experienced
large fluctuations in sales from quarter-to-quarter due to a wide variety of
factors, such as delay, cancellation or acceleration of customer projects, and
other factors discussed below. The Company's sales for a given quarter may
depend to a significant degree upon planned product shipments to a single
customer, often related to specific equipment deployment projects. The Company
has experienced both acceleration and slowdown in orders related to such
projects, causing changes in the sales level of a given quarter relative to both
the preceding and subsequent quarters.
Delays or lost sales can be caused by other factors beyond the Company's
control, including late deliveries by other vendors of components in a
customer's system, changes in implementation priorities, slower than anticipated
growth in demand for the services that the Company's products support and delays
in obtaining regulatory approvals for new services. Delays and lost sales have
occurred in the past and may occur in the future. Operating results in recent
periods have been adversely affected by delays in receipt of significant
purchase orders from customers. Certain of the Company's customers have delayed
orders in the past as a result of a diversion of their resources to network
integration and the Year 2000 issues. This trend may continue or worsen and
result in additional order delays or cancellations. In addition, the Company has
in the past experienced delays as a result of the need to modify its products to
comply with unique customer specifications. These and similar delays or lost
sales could materially adversely affect the Company's business, financial
condition and results of operations. See "Customer Concentration" and
"Dependence on Component Availability and Key Suppliers".
The Company's backlog at the beginning of each quarter typically is not
sufficient to achieve expected sales for that quarter. To achieve its sales
objectives, the Company is dependent upon obtaining orders in a quarter for
shipment in that quarter. Furthermore, the Company's agreements with its
customers typically provide that they may change delivery schedules and cancel
orders within specified timeframes, typically up to 30 days prior to the
scheduled shipment date, without significant penalty. The Company's customers
have in the past built, and may in the future build, significant inventory in
order to facilitate more rapid deployment of anticipated major projects or for
other reasons. Decisions by such customers to reduce their inventory levels
could lead to reductions in purchases from the Company. These reductions, in
turn, could cause fluctuations in the Company's operating results and could have
an adverse effect on the Company's business, financial condition and results of
operations in the periods in which the inventory is reduced.
The Company's industry is characterized by declining prices of existing
products, and therefore continual improvement of manufacturing efficiencies and
introduction of new products and enhancements to existing products are required
to maintain gross margins. In response to customer demands or competitive
pressures, or to pursue new
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<PAGE> 14
product or market opportunities, the Company may take certain pricing or
marketing actions, such as price reductions, volume discounts, or provision of
services at below-market rates. These actions could materially and adversely
affect the Company's operating results.
Operating results may also fluctuate due to factors such as the timing of
new product announcements and introductions by the Company, its major customers
or its competitors, delays in new product introductions by the Company, market
acceptance of new or enhanced versions of the Company's products, changes in the
product or customer mix of sales, changes in the level of operating expenses,
competitive pricing pressures, the gain or loss of significant customers,
increased research and development and sales and marketing expenses associated
with new product introductions, and general economic conditions. All of the
above factors are difficult for the Company to forecast, and these or other
factors can materially adversely affect the Company's business, financial
condition and results of operations for one quarter or a series of quarters. The
Company's expense levels are based in part on its expectations regarding future
sales and are fixed in the short term to a large extent. Therefore, the Company
may be unable to adjust spending in a timely manner to compensate for any
unexpected shortfall in sales. Any significant decline in demand relative to the
Company's expectations or any material delay of customer orders could have a
material adverse effect on the Company's business, financial condition and
results of operations. There can be no assurance that the Company will be able
to sustain profitability on a quarterly or annual basis. In addition, the
Company has had, and in some future quarter may have operating results below the
expectations of public market analysts and investors. In such event, the price
of the Company's common stock would likely be materially and adversely affected.
See "Potential Volatility of Stock Price".
The Company's products are covered by warranties and the Company is subject
to contractual commitments concerning its products. If unexpected circumstances
arise such that the product does not perform as intended and the Company is not
successful in resolving product quality or performance issues, there could be an
adverse effect on the Company's business, financial condition and results of
operations.
Potential Volatility of Stock Price. The trading price of the Company's
common stock could be subject to wide fluctuations in response to
quarter-to-quarter variations in operating results, announcements of
technological innovations or new products by the Company or its competitors,
developments with respect to patents or proprietary rights, general conditions
in the telecommunication network access and equipment industries, changes in
earnings estimates by analysts, or other events or factors. In addition, the
stock market has experienced extreme price and volume fluctuations, which have
particularly affected the market prices of many technology companies and which
have often been unrelated to the operating performance of such companies.
Company-specific factors or broad market fluctuations may materially adversely
affect the market price of the Company's common stock. The Company has
experienced significant fluctuations in its stock price and share trading volume
since its initial public offering in June 1996. There is no assurance that such
fluctuations will not continue.
Dependence on Current and Recently Introduced Products, and Products Under
Development. The Company's future results of operations are highly dependent on
market acceptance of existing and future applications for both the Company's
Access System 2000 and the Access System 3000 product lines. The Access System
2000 product line represented approximately 86% of sales in fiscal 1998 and 80%
of sales in fiscal 1997. Market acceptance of both the Company's current and
future product lines is dependent on a number of factors, not all of which are
in the Company's control, including the continued growth in the use of bandwidth
intensive applications, continued deployment of new telecommunications services,
market acceptance of integrated access devices in general, the availability and
price of competing products and technologies, and the success of the Company's
sales efforts. Failure of the Company's products to achieve market acceptance
would have a material adverse effect on the Company's business, financial
condition and results of operations. Failure to introduce new products in a
timely manner could cause companies to purchase products from competitors and
have a material adverse effect on the Company's business, financial condition
and results of operations. Due to a variety of factors, the Company may
experience delays in developing its planned products. New products may require
additional development work, enhancement, testing or further refinement before
the Company can make them commercially available. The Company has in the past
experienced delays in the introduction of new products, product applications and
enhancements due to a variety of internal factors, such as reallocation of
priorities, difficulty in hiring sufficient qualified personnel and unforeseen
technical obstacles, as well as changes in customer requirements. Although the
Company does not believe that such delays have had a material adverse effect on
its customer relationships, such delays have deferred the receipt of revenue
from the products involved. If the Company's
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<PAGE> 15
products have performance, reliability or quality shortcomings, then the Company
may experience reduced orders, higher manufacturing costs, delays in collecting
accounts receivable and additional warranty and service expenses.
Risks Associated with the Acquisition of TxPort. In addition to risks
described under "Risks Associated With Potential Acquisitions," the Company
faces significant risks associated with its recent acquisition of TxPort. There
can be no assurance that the Company will realize the desired benefits of this
acquisition. In order to successfully integrate TxPort, the Company must, among
other things, continue to attract and retain key personnel, integrate the
acquired products and technology from engineering, sales and marketing
perspectives, and consolidate functions and facilities. Difficulties encountered
in the integration may have a material adverse effect on the Company's business,
financial condition and results of operations.
The Company used purchase accounting in connection with the acquisition of
TxPort, resulting in a charge to be taken in each of the next three to ten years
for the amortization of intangible assets. As a result, the Company expects that
the acquisition will be dilutive to earnings in fiscal 1999.
Risks Associated With Potential Acquisitions. An important element of the
Company's strategy is to review acquisition prospects that would compliment its
existing product offerings, augment its market coverage, enhance its
technological capabilities or offer growth opportunities. Future acquisitions by
the Company could result in potentially dilutive issuance of equity securities,
use of cash and/or the incurring of debt and the assumption of contingent
liabilities, any of which could have a material adverse effect on the Company's
business and operating results and/or the price of the Company's common stock.
Acquisitions entail numerous risks, including difficulties in the assimilation
of acquired operations, technologies and products, diversion of management's
attention from other business concerns, risks of entering markets in which the
Company has limited or no prior experience and potential loss of key employees
of acquired organizations. The Company's management has limited prior experience
in assimilating acquired organizations. No assurance can be given as to the
ability of the Company to successfully integrate any businesses, products,
technologies or personnel that might be acquired in the future, and the failure
of the Company to do so could have a material adverse effect on the Company's
business and operating results.
Enterprise Resource Planning. The Company is currently engaged in a major
project to upgrade its enterprise-wide database and information management
systems, based principally on software from Oracle. The Company anticipates the
project completion date to be in the fourth quarter of the current fiscal year.
However, there can be no assurance that the Company will not experience
significant disruption as a result of unexpected delays in the implementation
process, or that the Company will not complete the project within the planned
time frame or budget. Significant delays may have a material adverse impact on
the Company's business, financial condition and results of operations.
Need to Expand Marketing Organization and Channels of Distribution.
Currently the Company sells its products to a small number of customers through
a relatively small sales force. The Company's strategy is to distribute and
market its products to a broader customer base, which will require the Company
to significantly expand its channels of distribution. There can be no assurance
that the Company will be able to recruit, train, motivate and manage additional
qualified marketing personnel with the requisite experience and knowledge, or
attract additional qualified distributors. Availability of qualified product
marketing personnel is limited, and competition for experienced personnel in the
network access and telecommunications equipment industries is intense. The
failure to timely expand its channels of distribution and product marketing
organization could have a material adverse effect on the Company's business,
financial condition and results of operations. See "Customer Concentration",
"Management of Growth" and "Dependence on Key Personnel".
Dependence on Component Availability and Key Suppliers. On-time delivery of
the Company's products depends upon the availability of components and
subsystems used in its products. The Company depends in part upon suppliers to
manufacture, assemble and deliver components in a timely and satisfactory
manner. The Company obtains several components and licenses certain embedded
software from single or limited sources. There can be no assurance that these
suppliers will continue to be able and willing to meet the Company's
requirements for any such components. The Company generally does not have any
long-term contracts with such suppliers, other than software vendors. Any
significant interruption in the supply of, or degradation in the quality of, any
such item could have a material adverse effect on the Company's results of
operations. The Company has no current plans to significantly expand its
supplier base.
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<PAGE> 16
Purchase orders from the Company's customers frequently require delivery
quickly after placement of the order. As the Company does not maintain
significant component inventories, delay in shipment by a supplier could lead to
lost sales. The Company uses internal forecasts to determine its general
materials and components requirements. Lead times for materials and components
may vary significantly, and depend on factors such as specific supplier
performance, contract terms and general market demand for components. If orders
vary from forecasts, the Company may experience excess or inadequate inventory
of certain materials and components. From time to time, the Company has
experienced shortages and allocations of certain components, resulting in delays
in fulfillment of customer orders. Such shortages and allocations could have a
material adverse effect on the Company's business, financial condition and
results of operations. See "Fluctuations in Quarterly Operating Results".
Competition. The market for telecommunications network access equipment is
highly competitive, and the Company expects competition to increase in the
future. This market is subject to rapid technological change, regulatory
developments, and new entrants. The market for integrated access devices such as
the Company's Access System product line is subject to rapid change. The Company
believes that the primary competitive factors in this market are the development
and rapid introduction of new product features, price and performance, support
for multiple types of communications services, network management, reliability,
and quality of customer support. There can be no assurance that the Company's
current products and future products under development will be able to compete
successfully with respect to these or other factors. The Company's principal
competition to date for its Access System product line has been from Digital
Link Corporation, Kentrox, a division of ADC Telecommunications and Larscom,
Inc., a subsidiary of Axel Johnson. In addition, the Company expects substantial
competition from companies in the computer networking market and other related
markets such as Newbridge Networks Corporation, Telco Systems, Inc., a division
of World Access, Inc., Visual Networks Inc., and Adtran, Inc. To the extent that
current or potential competitors can expand their current offerings to include
products that have functionality similar to the Company's products and planned
products, the Company's business, financial condition and results of operations
could be materially adversely affected.
The Company believes that the market for basic network termination products
is mature and that the principal competitive factors in this market are price,
installed base and quality of customer support. In this market, the Company
primarily competes with Adtran, Digital Link, Kentrox, Paradyne and Larscom.
There can be no assurance that such companies or other competitors will not
introduce new products that provide greater functionality and/or at a lower
price than the Company's like products. In addition, advanced termination
products are emerging which represent both new market opportunities as well as a
threat to current products. Furthermore, basic line termination functions are
increasingly being integrated by competitors into other equipment such as
routers and switches, which include direct WAN interfaces in certain products,
eroding the addressable market for separate network termination products.
Many of the Company's current and potential competitors have substantially
greater technical, financial, manufacturing and marketing resources than the
Company. In addition, many of the Company's competitors have long-established
relationships with network service providers. There can be no assurance that the
Company will have the financial resources, technical expertise, manufacturing,
marketing, distribution and support capabilities to compete successfully in the
future.
Rapid Technological Change. The network access and telecommunications
equipment markets are characterized by rapidly changing technologies and
frequent new product introductions. The rapid development of new technologies
increases the risk that current or new competitors could develop products that
would reduce the competitiveness of the Company's products. The Company's
success will depend to a substantial degree upon its ability to respond to
changes in technology and customer requirements. This will require the timely
selection, development and marketing of new products and enhancements on a
cost-effective basis. The development of new, technologically advanced products
is a complex and uncertain process, requiring high levels of innovation. The
development of new products for the WAN access market requires competence in the
general areas of telephony, data networking, network management and wireless
telephony as well as specific technologies such as DSL, ISDN, Frame Relay, ATM
and IP. Furthermore, the communications industry is characterized by the need to
design products which meet industry standards for safety, emissions and network
interconnection. With new and emerging technologies and service offerings from
network service providers, such standards are often changing or unavailable. As
a result, there is a potential for product development delays due to the need
for compliance with new or modified standards. The introduction of new and
enhanced products also requires that the Company manage transitions from older
products in order to minimize
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<PAGE> 17
disruptions in customer orders, avoid excess inventory of old products and
ensure that adequate supplies of new products can be delivered to meet customer
orders. There can be no assurance that the Company will be successful in
developing, introducing or managing the transition to new or enhanced products,
or that any such products will be responsive to technological changes or will
gain market acceptance. The Company's business, financial condition and results
of operations would be materially adversely affected if the Company were to be
unsuccessful, or to incur significant delays in developing and introducing such
new products or enhancements. See "Dependence on Recently Introduced Products
and Products under Development".
Management of Growth. The Company has recently experienced growth in the number
of its employees and the scope of its operations as a result of its recent
acquisition. To manage potential future growth effectively, the Company must
improve its operational, financial and management information systems and must
hire, train, motivate and manage a growing number of employees. The future
success of the Company also will depend on its ability to increase its customer
support capability and to attract and retain qualified technical, marketing and
management personnel, for whom competition is intense. In particular, the
current availability of qualified personnel is quite limited, and competition
among companies for such personnel is intense. The Company is currently
attempting to hire a number of product marketing and engineering personnel and
has experienced delays in filling such positions and expects to experience
continued difficulty in filling its needs for qualified personnel. There can be
no assurance that the Company will be able to effectively achieve or manage any
such growth, and failure to do so could delay product development and
introduction cycles or otherwise have a material adverse effect on the Company's
business, financial condition and results of operations. See "Need to Expand
Sales and Marketing Organizations and Channels of Distribution" and "Dependence
on Key Personnel".
Compliance with Regulations and Evolving Industry Standards. The market for
the Company's products is characterized by the need to meet a significant number
of communications regulations and standards, some of which are evolving as new
technologies are deployed. In the United States, the Company's products must
comply with various regulations defined by the Federal Communications Commission
and standards established by Underwriters Laboratories and Bell Communications
Research. For some public carrier services, installed equipment does not fully
comply with current industry standards, and this noncompliance must be addressed
in the design of the Company's products. Standards for new services such as
frame relay, performance monitoring services and ATM are still evolving. As
these standards evolve, the Company will be required to modify its products or
develop and support new versions of its products. The failure of the Company's
products to comply, or delays in compliance, with the various existing and
evolving industry standards could delay introduction of the Company's products,
which could have a material adverse effect on the Company's business, financial
condition and results of operations.
Government regulatory policies are likely to continue to have a major
impact on the pricing of existing as well as new public network services and
therefore are expected to affect demand for such services and the
telecommunications products that support such services. Tariff rates, whether
determined by network service providers or in response to regulatory directives,
may affect the cost effectiveness of deploying communication services. Such
policies also affect demand for telecommunications equipment, including the
Company's products.
Risks Associated With Entry into International Markets. The Company to date
has had minimal direct sales to customers outside of North America. The Company
has little experience in the European and Far Eastern markets, but intends to
expand sales of its products outside of North America and to enter certain
international markets, which will require significant management attention and
financial resources. Conducting business outside of North America is subject to
certain risks, including longer payment cycles, unexpected changes in regulatory
requirements and tariffs, difficulties in staffing and managing foreign
operations, greater difficulty in accounts receivable collection and potentially
adverse tax consequences. To the extent any Company sales are denominated in
foreign currency, the Company's sales and results of operations may also be
directly affected by fluctuations in foreign currency exchange rates. In order
to sell its products internationally, the Company must meet standards
established by telecommunications authorities in various countries, as well as
recommendations of the Consultative Committee on International Telegraph and
Telephony. A delay in obtaining, or the failure to obtain, certification of its
products in countries outside the United States could delay or preclude the
Company's marketing and sales efforts in such countries, which could have a
material adverse effect on the Company's business, financial condition and
results of operations.
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<PAGE> 18
Risk of Third Party Claims of Infringement. The network access and
telecommunications equipment industries are characterized by the existence of a
large number of patents and frequent litigation based on allegations of patent
infringement. From time to time, third parties may assert exclusive patent,
copyright, trademark and other intellectual property rights to technologies that
are important to the Company. The Company has not conducted a formal patent
search relating to the technology used in its products, due in part to the high
cost and limited benefits of a formal search. In addition, since patent
applications in the United States are not publicly disclosed until the related
patent is issued and foreign patent applications generally are not publicly
disclosed for at least a portion of the time that they are pending, applications
may have been filed which, if issued as patents, could relate to the Company's
products. Software comprises a substantial portion of the technology in the
Company's products. The scope of protection accorded to patents covering
software-related inventions is evolving and is subject to a degree of
uncertainty which may increase the risk and cost to the Company if the Company
discovers third party patents related to its software products or if such
patents are asserted against the Company in the future. Patents have been
granted recently on fundamental technologies in software, and patents may be
issued which relate to fundamental technologies incorporated into the Company's
products. The Company has received and may receive in the future communications
from third parties asserting that the Company's products infringe or may
infringe the proprietary rights of third parties. In its sales and distribution
agreements, the Company typically agrees to indemnify its customers for any
expenses or liabilities resulting from claimed infringements of patents,
trademarks or copyrights of third parties. In the event of litigation to
determine the validity of any third-party claims, such litigation, whether or
not determined in favor of the Company, could result in significant expense to
the Company and divert the efforts of the Company's technical and management
personnel from productive tasks. In the event of an adverse ruling in such
litigation, the Company might be required to discontinue the use and sale of
infringing products, expend significant resources to develop non-infringing
technology or obtain licenses from third parties. There can be no assurance that
licenses from third parties would be available on acceptable terms, if at all.
In the event of a successful claim against the Company and the failure of the
Company to develop or license a substitute technology, the Company's business,
financial condition and results of operations would be materially adversely
affected.
Limited Protection of Intellectual Property. The Company relies upon a
combination of patent, trade secret, copyright and trademark laws and
contractual restrictions to establish and protect proprietary rights in its
products and technologies. The Company has been issued certain U.S. and Canadian
patents with respect to limited aspects of its single purpose network access
technology. The Company has not obtained significant patent protection for its
Access System technology. There can be no assurance that third parties have not
or will not develop equivalent technologies or products without infringing the
Company's patents or that the Company's patents would be held valid and
enforceable by a court having jurisdiction over a dispute involving such
patents. The Company has also entered into confidentiality and invention
assignment agreements with its employees and independent contractors, and enters
into non-disclosure agreements with its suppliers, distributors and appropriate
customers so as to limit access to and disclosure of its proprietary
information. There can be no assurance that these statutory and contractual
arrangements will deter misappropriation of the Company's technologies or
discourage independent third-party development of similar technologies. In the
event such arrangements are insufficient, the Company's business, financial
condition and results of operations could be materially adversely affected. The
laws of certain foreign countries in which the Company's products are or may be
developed, manufactured or sold may not protect the Company's products or
intellectual property rights to the same extent as do the laws of the United
States and thus, make the possibility of misappropriation of the Company's
technology and products more likely.
Dependence on Key Personnel. The Company's future success will depend to a
large extent on the continued contributions of its executive officers and key
management, sales and technical personnel. The Company is a party to agreements
with certain of its executive officers to help ensure the officer's continual
service to the Company in the event of a change-in-control. Each of the
Company's executive officers, and key management, sales and technical personnel
would be difficult to replace. The loss of the services of one or more of the
Company's executive officers or key personnel, or the inability to continue to
attract qualified personnel could delay product development cycles or otherwise
have a material adverse effect on the Company's business, financial condition
and results of operations. See "Management of Growth".
Antitakeover Effects of Certain Charter Provisions. The Company's Board of
Directors has the authority to issue up to 1,000,000 shares of Preferred Stock
and to determine the price, rights, preferences and privileges of those shares
without any further vote or action by the stockholders. The rights of the
holders of common stock will be subject to, and may be adversely affected by,
the rights of the holders of any Preferred Stock that may be issued in the
future. The
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<PAGE> 19
issuance of shares of Preferred Stock, while potentially providing
desirable flexibility in connection with possible acquisitions and other
corporate purposes, could have the effect of making it more difficult for a
third party to acquire a majority of the outstanding voting stock of the
Company. The Company has no present intention to issue shares of Preferred
Stock. In addition, the Company is subject to the anti-takeover provisions of
Section 203 of the Delaware General Corporation Law, which will prohibit the
Company from engaging in a "business combination" with an "interested
stockholder" for a period of three years after the date of the transaction in
which the person became an interested stockholder, unless the business
combination is approved in a prescribed manner. The application of Section 203
also could have the effect of delaying or preventing a change of control of the
Company. Furthermore, certain provisions of the Company's Amended and Restated
Certificate of Incorporation, including provisions that provide for the Board of
Directors to be divided into three classes to serve for staggered three-year
terms, may have the effect of delaying or preventing a change of control of the
Company, which could adversely affect the market price of the Company's common
stock.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Not applicable.
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PART II. OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits Index:
<TABLE>
<CAPTION>
Exhibit Number Description of Exhibit
-------------- ----------------------
<S> <C>
10.28 Employment Agreement between Registrant and
Graham Pattison dated March 22, 1999.
10.29 Retirement Agreement between Registrant and
Leigh S. Belden dated April 9, 1999.
10.30 Retirement Agreement between Registrant and
Steve S. Taylor dated April 9, 1999.
10.31 Severance Agreement between Registrant and
Stephen M. Tennis dated April 9, 1999
27.1 Financial Data Schedule
</TABLE>
(b) The Company filed no reports on Form 8-K during the quarter ended March
28, 1999.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
VERILINK CORPORATION
May 7, 1999 By: /s/ John C. Batty
-------------------------
John C. Batty,
Vice President, Finance and Chief
Financial Officer (Duly Authorized
Officer and Principal Financial
Officer)
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<PAGE> 22
EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibit Number Description of Exhibit
-------------- ----------------------
<S> <C>
10.28 Employment Agreement between Registrant and
Graham Pattison dated March 22, 1999.
10.29 Retirement Agreement between Registrant and
Leigh S. Belden dated April 9, 1999.
10.30 Retirement Agreement between Registrant and
Steve S. Taylor dated April 9, 1999.
10.31 Severance Agreement between Registrant and
Stephen M. Tennis dated April 9, 1999
27.1 Financial Data Schedule
</TABLE>
<PAGE> 1
EXHIBIT 10.28
March 22, 1999
Graham Pattison
80 Comstock Drive
Wrentham, MA 02093
Dear Graham:
I am pleased to extend to you an offer of employment for the position of
President and CEO of Verilink Corporation. The terms and conditions of your
employment will be as follows:
1. Your employment will commence not later than April 12, 1999. You will
report to the Company's Board of Directors.
2. Your base compensation will initially be $11,538.47 paid bi-weekly
(annualized salary of $300,000.00). Executive compensation is reviewed
annually after the end of Verilink's June 30 fiscal year end. Any increase
in salary is at the sole discretion of the Board of Directors.
3. You will receive such benefits as are customarily granted to officers of
Verilink. Attachment 1 sets forth the benefits currently available to
Verilink employees generally and to Verilink executive officers, except
that your automobile allowance will be $1,000.00 per month. Please note
that officers do not participate in the profit sharing plan. These
benefits are subject to review from time-to-time by the Compensation
Committee of the Board of Directors.
4. Contingent upon your acceptance of this offer of employment, and subject
to the Board of Directors' approval, Verilink will grant you a
Non-Qualified Stock Option which gives you the right to purchase, under
terms stated in your Stock Option Agreement, 400,000 shares of Verilink
Common Stock at the fair market value as determined by the Board of
Directors on the date of the grant. Vesting will occur over 4 years at the
rate of 2.08% (1/48th) at the end of each month, assuming continuous
employment.
5. You will be eligible for participation in Verilink's Management Incentive
Plan for fiscal 2000 (July 1, 1999 - June 30, 2000) and thereafter. The
Plan will provide for a target potential payout to you of 50% of your base
salary upon achievement of
<PAGE> 2
Graham Pattison
March 22, 1999
Page 2
your objectives under the Plan, but in no event less than a guaranteed
payment to you for fiscal 2000 of one-half of your target bonus (25% of
base salary), which guaranteed payment is subject to completion and
approval by the Board of a corporate business plan prior to the end of
fiscal 1999 and to your still being employed by Verilink at the end of
fiscal 2000.
6. During the first year of employment, if your employment is terminated by
Verilink other than for cause, whether or not a change of control has
occurred, you will receive two years' base salary, including applicable
benefits, with vested options available to execute for up to a period of
twelve additional months. If your employment is terminated by Verilink
other than for cause during the second year of employment, you will
receive one year's base salary, including applicable benefits, with vested
options available to execute for up to a period of twelve additional
months. If such termination occurs after a change in control, you will
also receive such additional benefits as are provided in the Verilink
Change of Control Severance Benefits Agreement (Attachment 2). At
Verilink's option, the foregoing severance may be paid as salary
continuation or as a lump sum. After two years of employment, any
severance benefits will be subject to the Change of Control Severance
Benefits Agreement and other then existing practices applicable to
Verilink's executive officers. For purposes of this paragraph, "cause"
shall be defined as any act or failure to act involving dishonesty towards
Verilink; unethical business practices; embezzlement or misappropriation
of corporate funds, property or proprietary information; unreasonable and
willful refusal to perform the duties required by Verilink; willful breach
of this Agreement or habitual neglect of duties and responsibilities,
other than due to illness or disability; aiding and abetting a competitor;
or participation in any fraud or any criminal activities.
7. For a period of up to 180 days after the commencement of your employment,
Verilink will provide you with temporary housing. In addition, Verilink
shall reimburse you for your moving costs, travel associated with your
move, and other relocation costs. Attachment 3 sets forth Verilink's
standard relocation policies. You and Verilink's Human - Resources
Department will mutually agree upon the application of those policies to
your situation. The total relocation assistance shall not exceed $125,000.
If you voluntarily terminate your employment within 12 months after
commencement of employment, you will repay Verilink the amount of the
foregoing relocation payments. If you voluntarily terminate your
employment between 12 months and 18 months after commencement of
employment, you will repay Verilink a pro-rata portion of the relocation
payment based upon the number of months remaining to 18 months divided by
six. Please understand this offer of relocation is a confidential,
one-time offer for you only. It is not Verilink's intention for this
relocation package to become permanent policy.
<PAGE> 3
Graham Pattison
March 22, 1999
Page 3
8. If you do not sell your existing home within 90 days of commencement of
employment and you make a written offer that is accepted to purchase a new
home in California, which purchase is scheduled to close prior to the sale
of your existing home, Verilink shall loan you an amount equal to the
"equity" in your existing home (fair market value less encumbrances). That
loan will be interest-free and shall be repaid by you on the earlier of
the closing sale of your existing home or twelve months after the
commencement of your employment. You agree to use your best efforts to
sell your existing home as soon as possible. During the first six months
of your employment, Verilink will also reimburse you for any mortgage
payments upon your existing home made by you after you purchase a new home
in California.
9. Verilink shall provide you with a housing assistance loan of $600,000.00
in accordance with Attachment 4. This Note will be secured by a second
deed of trust on your California property.
10. Subject to any severance benefits described in this letter, your
employment with Verilink is voluntarily entered into and is for no
specific period. As a result, you are free to resign at any time, for any
reason or for no reason. Similarly, Verilink is free to conclude its
at-will employment relationship with you at any time, with or without
cause.
11. In the event of any dispute or claims relating to or arising out of our
employment relationship, you and Verilink agree that all such disputes
shall be fully and finally resolved by binding arbitration conducted by
the American Arbitration Association in San Jose, California. However, we
agree that this arbitration provision shall not --- apply to any dispute
or claims relating to or arising out of the misuse or misappropriation of
the Company's trade secrets or proprietary or confidential information or
to enforcement of your rights under the Change of Control Severance
Benefits Agreement.
12. This offer of employment is contingent upon the following:
(a) A completed employment application.
(b) Full compliance with the Immigration Reform and Control Act of 1986,
which requires new employees to provide documentation/identification
to establish both identity and work authorization within three (3)
days of your employment.
(c) On your date of hire, you will be required to sign a Verilink
Confidentiality Agreement (Attachment 5) as part of your total
employment package.
<PAGE> 4
Graham Pattison
March 22, 1999
Page 4
(d) If you will be driving your personal automobile for company business
on a regular basis, you will be required to provide proof of personal
auto insurance.
If you have any questions regarding the nature of any of this
documentation, please contact the Human Resources Department.
13. This letter, together with all attachments hereto, set forth the terms of
your employment with Verilink and supersede any prior representations or
agreements, whether written or oral. This letter may not be modified or
amended except by an instrument in writing, signed by Verilink and by you.
Verilink has grown to be a well respected company in the telecommunications
industry. We are pleased to have you join the Verilink team, and we look forward
to your participation in our continued success.
This offer remains effective until March 21, 1999. Please acknowledge your
acceptance by signing this letter and returning it to me at your earliest
convenience.
Sincerely,
VERILINK CORPORATION
/s/ LEIGH S. BELDEN
Leigh S. Belden
President and CEO
I accept the foregoing offer:
/s/ GRAHAM PATTISON
- ------------------------------
Graham Pattison
Date: MARCH '99
-------------------------
<PAGE> 1
EXHIBIT 10.29
April 9, 1999
Leigh S. Belden
President and CEO
Verilink Corporation
145 Baytech Drive
San Jose, CA 95134
Dear Leigh:
Leigh S. Belden April 9, 1999 Page 2 This letter shall set forth the terms and
conditions of your retirement as an active employee of Verilink Corporation.
Those terms and conditions are:
1. You shall receive a lump sum payment in an amount equal to two years'
current salary, less applicable withholdings.
2. You shall receive the sum of $95,000, which approximates twice the average
annual amount paid to you for your automobile allowance and reimbursement
of auto, legal, financial planning, health club and fitness expenses. You
acknowledge that Verilink intends to terminate any automobile insurance
covering your automobiles and that you will be responsible for obtaining
your own automobile insurance coverage.
3. You shall receive the sum of $90,000, which is intended to reimburse you
for the cost of office space, furnishings and equipment, and
administrative assistance for a period of two years.
4. Verilink shall maintain for you and your family until you reach the age of
65 health, dental and vision insurance comparable to that provided to
Verilink's officers. Verilink shall pay the cost of such insurance for two
years. Thereafter, you shall reimburse Verilink for such costs; provided,
however, that your responsibility shall not exceed the amount of the
average premium paid by Verilink for its officers. In addition, consistent
with existing practice, Verilink will pay unreimbursed medical costs for
you and your family for a period of two years.
<PAGE> 2
Leigh S. Belden
April 9, 1999
Page 2
5. Verilink shall pay the reasonable and necessary expenses incurred by you
in connection with TIA and EIA activities, including, but not limited to,
first class air travel for you and your spouse.
6. Upon termination of your employment, you shall be entitled to retain your
cellular telephone, two computers, Palm Pilot, miscellaneous equipment and
office furniture currently used by you.
7. You will be granted a nonqualified stock option to acquire 15,625 shares
of Verilink common stock at a price equal to the fair market value of such
stock on the date of grant.
8. The payments described in paragraphs 1, 2 and 3 shall be made to you on or
before April 13, 1999.
9. You shall continue to serve as a member of Verilink's Board of Directors.
Upon your retirement, you shall be granted a non-employee director stock
option pursuant to Verilink's 1993 Amended and Restated Stock Option Plan.
Please indicate your agreement with the foregoing by signing and returning this
letter.
Very truly yours,
VERILINK CORPORATION
/s/ HOWARD ORINGER
Howard Oringer
Chairman of the Board
Agreed:
/s/ LEIGH S. BELDEN
- ---------------------------
Leigh S. Belden
Date: 4-13-99
----------------------
<PAGE> 1
EXHIBIT 10.30
April 9, 1999
Steven C. Taylor
Chief Technology Officer
Verilink Corporation
145 Baytech Drive
San Jose, CA 95134
Dear Steve:
This letter shall set forth the terms and conditions of your retirement as an
active employee of Verilink Corporation. Those terms and conditions are:
1. You shall receive a lump sum payment in an amount equal to two years'
current salary, less applicable withholdings.
2. You shall receive the sum of $95,000, which approximates twice the average
annual amount paid to you for your automobile allowance and reimbursement
of auto, legal, financial planning, health club and fitness expenses. You
will be responsible for making all payments required under the lease for
the automobile currently provided by Verilink. You acknowledge that
Verilink intends to terminate any automobile insurance covering your
automobiles and that you will be responsible for obtaining your own
automobile insurance coverage.
3. You shall receive the sum of $90,000, which is intended to reimburse you
for the cost of office space, furnishings and equipment, and
administrative assistance for a period of two years.
4. Verilink shall maintain for you and your family until you reach the age of
65 health, dental and vision insurance comparable to that provided to
Verilink's officers. Verilink shall pay the cost of such insurance for two
years. Thereafter, you shall reimburse Verilink for such costs; provided,
however, that your responsibility shall not exceed the amount of the
average premium paid by Verilink for its officers. In addition, consistent
with existing practice, Verilink will pay unreimbursed medical costs for
you and your family for a period of two years.
<PAGE> 2
Steven C. Taylor
April 9, 1999
Page 2
5. Upon termination of your employment, you shall be entitled to retain your
cellular telephone, computer, Palm Pilot, miscellaneous equipment and
office furniture currently used by you.
6. You will be granted a nonqualified stock option to acquire 15,625 shares
of Verilink common stock at a price equal to the fair market value of such
stock on the date of grant.
7. The payments described in paragraphs 1, 2 and 3 shall be made to you on or
before April 13, 1999.
8. You shall continue to serve as a member of Verilink's Board of Directors.
Upon your retirement, you shall be granted a non-employee director stock
option pursuant to Verilink's 1993 Amended and Restated Stock Option Plan.
Please indicate your agreement with the foregoing by signing and returning this
letter.
Very truly yours,
VERILINK CORPORATION
/s/ HOWARD ORINGER
- --------------------------
Howard Oringer
Chairman of the Board
Agreed:
/s/ STEVEN C. TAYLOR
- --------------------------
Steven C. Taylor
Date: 4/15/99
---------------------
<PAGE> 1
EXHIBIT 10.31
April 9, 1999
Stephen M. Tennis
Vice President, General Counsel
Verilink Corporation
145 Baytech Drive
San Jose, CA 95134
Dear Steve:
This letter will set forth the terms and conditions applicable to the
termination of your employment with Verilink Corporation.
1. You shall remain employed by Verilink until June 30, 1999. While employed,
your current salary and benefits shall continue.
2. Upon termination of your employment, you will receive a lump sum payment
equal to six months' then existing salary, less applicable withholdings.
In addition, you will receive the sum of $20,000, which approximates the
amount which would be paid to you for automobile allowance, miscellaneous
benefits and reimbursement of automobile expenses, health club and fitness
expenses, and unreimbursed medical expenses for six months.
3. Upon termination of your employment, you will receive a payment intended
to reimburse you for COBRA premiums for a period of six months. You will
be responsible for payment of your own COBRA premiums.
4. At the termination of your employment with Verilink, you shall continue to
provide services to Verilink as an independent contractor for a period of
one year. On the date of this letter, you shall receive a non-refundable
payment of $85,000. During that one-year period you agree to provide
Verilink a minimum of one-half of your normal billable hours, or
approximately 200 hours per quarter. Such services shall be provided at
such times and places as shall be determined by you. In addition to the
retainer, Verilink shall pay you the sum of $100,000 for such services,
payable quarterly in advance commencing on the date of your termination of
employment. You shall provide Verilink with a quarterly accounting of the
services rendered to Verilink, including a description of services and the
number of hours worked by you. If you render services for less than 180
hours during a quarter, the sum of
<PAGE> 2
Stephen M. Tennis
April 9, 1999
Page 2
$125.00 per hour of such deficiency shall be deducted from the payment due
for the next quarter. If you render services in excess of 200 hours during
a quarter, you shall be compensated for such services at a rate per hour
which represents a 20% discount from the hourly rate you charge third
parties for your services; provided, however, that if you render between
180 and 200 hours for any prior quarter, hours in excess of 200 hours
shall first be offset against such deficiency. Such excess hours shall be
accounted for quarterly and shall be paid by Verilink upon receipt of a
statement. At the end of one year, Verilink may continue the consulting
arrangement on such terms and conditions as are mutually agreeable to you
and Verilink. Verilink may terminate your services at any time after the
first quarter; provided, however, that in the event of any such
termination, Verilink shall pay you a sum equal to one-half of the
quarterly payments due for the remainder of the twelve-month period.
5. Upon termination of your employment, you shall be entitled to retain your
cellular telephone, Palm Pilot, other miscellaneous equipment and office
furniture currently used by you.
6. Your existing options to acquire 100,000 shares of Verilink common stock
(granted December 2, 1997, December 18, 1997, January 4, 1999, and April
13, 1999) shall be immediately vested and exercisable in full for a period
commencing on the date of this letter and ending twelve months from the
date of your termination of employment.
Please indicate your agreement with the foregoing by signing and returning this
letter.
Very truly yours,
VERILINK CORPORATION
/s/ HOWARD ORINGER
- -----------------------------
Howard Oringer
Chairman of the Board
Agreed:
/s/ STEPHEN M. TENNIS
- -----------------------------
Stephen M. Tennis
Date: 4/13/99
------------------------
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS FINANCIAL SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM
THE FINANCIAL STATEMENTS CONTAINED IN THE FORM 10-Q OF VERILINK CORPORATION FOR
THE SECOND FISCAL QUARTER ENDED DECEMBER 28, 1998 AND IS QUALIFIED IN ITS
ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> JUN-27-1999
<PERIOD-START> JUL-29-1998
<PERIOD-END> MAR-28-1999
<CASH> 20,988
<SECURITIES> 6,317
<RECEIVABLES> 6,216
<ALLOWANCES> 214
<INVENTORY> 6,842
<CURRENT-ASSETS> 41,974
<PP&E> 19,204
<DEPRECIATION> 10,956
<TOTAL-ASSETS> 59,548
<CURRENT-LIABILITIES> 16,295
<BONDS> 0
0
0
<COMMON> 140
<OTHER-SE> 43,113
<TOTAL-LIABILITY-AND-EQUITY> 59,548
<SALES> 12,003
<TOTAL-REVENUES> 12,003
<CGS> 7,392
<TOTAL-COSTS> 7,392
<OTHER-EXPENSES> 13,536
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> (8,650)
<INCOME-TAX> 0
<INCOME-CONTINUING> (8,650)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (8,650)
<EPS-PRIMARY> (0.62)<F1>
<EPS-DILUTED> (0.62)
<FN>
<F1>"For Purposes of this Exhibit, Primary Means Basic"
</FN>
</TABLE>
